In 2008, just one year after having assumed the post of prime minister and well before the end of his term as party leader or the end of the legislative term of the Diet (parliament), Yasuo Fukuda surprised Japan’s political establishment and others around the world by announcing that he was stepping down. He made the announcement on September 1, almost exactly a year after his predecessor, Shinzo Abe, had made a similarly unexpected announcement. Though Abe had explained his decision as resulting from his gastrointestinal problems, Fukuda was not able to point to any health problems as a reason for stepping down. He simply chose to move aside, he explained, in order to help accelerate a policy-making process that had been moving at a snail’s pace for the entire period of his prime ministership. Fukuda was succeeded on September 24 by Taro Aso, a fellow member of the long-ruling Liberal Democratic Party (LDP). Aso assumed the post of prime minister after having been selected by the LDP as party leader in a special LDP election scheduled to choose Fukuda’s successor.

Fukuda’s frustration was driven by the difficulties he had working with a “twisted Diet,” the Japanese term for divided control of the legislature. The opposition Democratic Party of Japan (DPJ) held a majority of the seats in the upper house, while the LDP, together with its coalition partner, the New Komeito party, held a two-thirds majority in the more powerful lower house of the Diet. The DPJ had won control of the upper house in July 2007—the first time that a party other than the LDP had won majority control of either house of the Diet in the post-World War II period. Abe’s resignation, his reports of stomach problems notwithstanding, was largely a result of that election loss.

It thus fell to Fukuda to deal with an awkward legislative situation that was new to Japan. Under the leadership of DPJ head Ichiro Ozawa, the party’s upper-house delegation remained united in refusing to compromise with the prime minister. In his first four months in office, Fukuda was able to usher through the Diet only a single significant piece of legislation: the renewal in January of antiterrorism legislation authorizing the Japanese navy to resume its mission in the Indian Ocean that involved refueling U.S. ships engaged in the war in Afghanistan.

In the spring term of the Diet, Fukuda was able to pass the budget on schedule by using the ruling coalition’s control of the lower house. In March, however, the opposition took advantage of the fact that the appointment of governors and deputy governors of the Bank of Japan (BOJ) required the approval of both chambers of the Diet. The DPJ blocked Fukuda’s efforts to appoint Toshiro Muto the new central bank governor, delaying the selection of a new chief until after the term of the outgoing governor, Toshihiko Fukui, had expired on March 19. The post thus stood vacant for several weeks—with Masaaki Shirakawa serving as acting chief—as an important meeting of the Group of Seven economic officials approached. Only the potential embarrassment of having Shirakawa attend this meeting as a mere “acting” governor compelled the DPJ to stand aside and allow him to assume the post of governor with Diet approval. Nevertheless, the drama continued when the DPJ announced that it would oppose Fukuda’s nominee for the open deputy governor’s slot. Over the remaining months of his tenure as prime minister, Fukuda was forced to abandon a series of proposed candidates. The standoff over this issue appeared to have been one of the headaches that pushed Fukuda to step down. A new deputy was approved on October 24.

Fukuda was involved in one final legislative showdown with the DPJ over the renewal of the “temporary” gasoline-tax surcharge. The surcharge, which had been in place since the oil-crisis years of the mid-1970s, had been repeatedly renewed because it produced an annual stream of tax revenue totaling an estimated ¥2.6 trillion (about $27.2 billion) that was used to fund road projects. The DPJ, citing the public’s concern over rising gas prices, refused to approve renewal ahead of the March 31 expiration date. Fukuda countered by proposing to redirect the gas-tax revenue from road projects to a fund used for general purposes. This plan was eventually approved on April 30, though Fukuda’s proposal was modified to reflect the demands of rank-and-file LDP members that the gas tax support road projects for one more year, after which such revenue would be directed to general-purpose use starting in 2009. This represented a major change in policy that former prime minister Junichiro Koizumi had pushed for unsuccessfully earlier in the decade.

The DPJ orchestrated one final effort to embarrass the prime minister. In June, just prior to a meeting of the Group of Eight (G-8) hosted by Japan, the upper house passed a motion of censure against the prime minister. While ostensibly designed to press Fukuda to call early elections for the lower house, the motion was (as expected) overridden by a vote of the LDP-dominated lower house, which under Japan’s constitution had the power to select the prime minister. Nevertheless, the vote was yet another reminder that Fukuda had only partial control of the legislature.

More worrisome for the LDP, however, was the prospect that the party would have to face the voters in lower-house elections by September 2009. Given the standing of the party and the prime minister in public-opinion polls, the LDP and its New Komeito allies looked certain to lose their two-thirds majority in that chamber in the next elections. Anything short of the two-thirds control that the party had wielded since the 2005 elections threatened to make the job of managing the Diet even more complicated, since that supermajority had been critical to Fukuda’s ability to push through legislation on several occasions during his tenure in office. A bare majority would leave the LDP completely dependent on opposition cooperation until at least the 2010 upper-house elections—and probably beyond that to 2013.

Having found the existing situation difficult enough, Fukuda decided to leave the task of leading the LDP into a general election to a successor. The party promptly focused on Aso as the man best situated to take on this challenge. After he assumed the party presidency on September 22, Aso was quickly approved by the lower house as the new prime minister. His approval rating immediately after taking office stood at 49% in most polls—higher than Fukuda’s at the end of his tenure but below where Fukuda’s had stood when he assumed office a year earlier. By November, Aso’s support had fallen to just 40% as it became clear that the economy was slowing sharply and that the financial crisis was driving the stock market to record lows. Asked which party they preferred, respondents in the November poll taken by the national newspaper Yomiuri preferred the LDP to the DPJ by just a single percentage point, 32% to 31%. Elections were likely to be held in the spring of 2009 if political conditions improved for the ruling coalition but possibly as late as the summer if Aso decided to wait until close to the September 2009 deadline.

The Economy

In late July the International Monetary Fund (IMF) reported that the Japanese economy was showing “resilience to recent external shocks” and that “activity remained robust through the first quarter of 2008.” By October, though, it was apparent that the worldwide economic slowdown that began in the U.S. after the collapse of the housing bubble was hitting Japan hard. During the second quarter, Japan’s economy contracted by 0.7%, or at an annual rate of 3%. Further contraction in the third quarter pushed the Japanese economy into recession in the fall.

A customer at a currency exchange bureau in Tokyo in late October 2008 watches in concern as the …

Issei Kato—Reuters/Landov

Growth was affected by the rise in Japan’s import bill as the country paid record-high prices for imported oil, combined with a slump in exports, which were hit by declining growth in the U.S. and Europe. The slowdown was also a product of developments at home, where both private residential investment and public investment declined sharply. As a result of the recession, projections for Japan’s growth during 2008 and 2009 were downgraded. Whereas the IMF’s midyear projections suggested that Japan would grow at a rate of about 1.5% during 2008–09, the projections it issued in September called for growth to slow to 1% in 2008 and 1.1% in 2009. Just two months later, after taking into account the effects of the spreading global financial crisis, the IMF lowered its projections for Japanese growth again.

The contraction of credit and the associated unwinding of the yen-carry trade, which led the yen to strengthen to 94 yen to the U.S. dollar on October 27 and to strengthen even more sharply against the euro and many other currencies, dealt a severe blow to Japanese automakers and other exporters. Automakers slashed projected sales in the U.S. and other markets and predicted much lower levels of profits. These developments fed a sharp decline in the Japanese stock markets; the Nikkei 225 Stock Average fell to a 26-year low in late October before recovering slightly at year’s end. The unemployment rate moved up to 4.2% in August after starting the year at 3.8% but fell back to the 3.7–3.9% range in the autumn.

In response to the slowdown, the government passed a fiscal stimulus package valued at ¥1.8 trillion (about $18.8 billion) in October and immediately began working on a second package. The latter became the top priority of the new cabinet inaugurated under Prime Minister Aso, who announced on October 30 that the package would be valued at ¥5 trillion (about $52.3 billion). The next day, the BOJ announced that it was lowering interest rates from 0.5% to 0.3%, the first time the central bank had cut rates in seven years. Additional measures designed to inject public funds into banks, along with a major stimulus package, worked their way through the Diet in late 2008 as the DPJ got out of the way of measures that were designed to deal with the urgent economic situation.

The fiscal and monetary policies adopted late in the year caused the Japanese government to backtrack from efforts to “normalize” interest rates, which had been at 0.5% or lower for the entire decade, and from efforts to reduce the country’s fiscal deficit to a level where it achieved a “primary balance” by fiscal year 2011. Private-sector forecasters predicted that Japan could reach this goal only if it raised the consumption tax, but such a tax hike was not even on the agenda as Japan faced both a recession and elections in 2009.

Foreign Affairs

The foreign policy issue that preoccupied senior Japanese officials in 2008 was the effort to persuade North Korea to give up its nuclear weapons program and take responsibility for past violations of international law—especially the kidnapping of Japanese citizens in the 1970s and ’80s. The good news was that the U.S. and North Korea agreed during the year on several steps that were aimed at resolving these issues. North Korea disabled its nuclear reactors in June after it reached a tentative agreement with the U.S. on a verification regime. This step was to be followed by the U.S. removal of North Korea from the list of countries that it considered state sponsors of terrorism and by the provision of one million tons of fuel to North Korea by South Korea, China, Russia, the U.S., and Japan—all participants in six-party talks on North Korean denuclearization. Because the tentative agreement on verification did not resolve all concerns on the U.S. side or address Japan’s kidnapping concerns, these moves were delayed into the fall, which caused North Korea to resort once again to brinkmanship by barring inspectors from its nuclear facilities at Yongbyon, threatening to resume production of plutonium, and moving toward another nuclear test. Hoping to avoid this, the U.S. announced on October 11 that it was indeed removing North Korea from its list of state sponsors of terrorism in exchange for verbal compromises by Pyongyang on the terms of the verification regime.

The bad news was that these compromises were not enough to reassure Japan, which announced that it was not willing to approve the deal. Japan insisted that it would agree to provide fuel oil only when details of the verification regime were put into writing and accepted by all participants in the six-party talks. Japan further demanded that the North Koreans carry out another investigation into the fate of the kidnap victims. Japanese officials blamed the U.S. for failing to adequately consider their concerns, and Aso went so far as to question the U.S. decision to make a deal with ailing North Korean leader Kim Jong Il, who, Aso claimed, was “incapable of making important judgments.”

This deterioration in relations with the U.S. amid continuing concerns about North Korea came during a time when Japan was able to improve its relations with China and Europe. Chinese Pres. Hu Jintao traveled to Japan in May—the first visit by a Chinese head of state since 1998. His trip—which came after several years in which visits by Japanese heads of state to the Yasukuni Shrine (where both Japanese war dead and 14 Class A war criminals were enshrined) and anti-Japanese demonstrations in China had aggravated relations between the two neighbours—marked a milestone in improving ties. Nevertheless, the two countries continued to face difficulties dealing with issues such as the Chinese tainted-food scandal, which caused problems throughout Asia and elsewhere during the year.

In July, Japan hosted the G-8 summit, which was held in Toyako on the island of Hokkaido. Much effort was devoted prior to the summit in working with the Europeans to nudge the U.S. toward taking a more productive role on climate-change negotiations. The summit’s crowning achievement was a commitment by the group—including the U.S.—to halve greenhouse gas emissions by 2050. The group also pledged to work to bring China and India and other large emitters of greenhouse gases into a new post-Kyoto Protocol climate-change-mitigation regime.